There are two fundamental values that are essential to any working capitalist economy: accountability and the rule of law. The reported outlines of the proposed settlement of the robo-mortgage scandal (no official details have been released) by 46 state attorneys general working together shows how far we have diverged from the basic principles of egalitarian capitalism.
This proposed settlement has no place in a capitalist economy. First, a successful housing recovery is essential to the ultimate recovery of the economy. So the implications of any settlement that potentially hurts the housing market are extraordinarily significant for the health of the nation. Second, it is based on principles that are unrecognizable in a nation built on capitalism and hence accountability and the rule of law.
Bank officials have testified in investigations of the robo-mortgage scandal that they submitted up to 10,000 false affidavits per month. Such testimony is effectively an admission of criminal guilt. These people admitted that, on behalf of their firms, they broke numerous criminal laws, most likely including conspiracy, fraud, and misleading the court.
The banks have attempted to deflect their misdeeds by suggesting that these illegal acts did not harm anyone. The laws were related to process only. The answer to such claims is that they are irrelevant. The banks are acknowledging that they perpetrated victimless crimes on a massive scale. And, each year, I suspect thousands of American citizens go to jail for perpetrating victimless crimes on a far lesser scale.
Moreover, these illegal acts demonstrate disrespect for the mortgage process. This same disrespect for appropriate processes, although not proven to be similarly criminal, is a large part of how our current mortgage mess was created in the first place. The banks ignored many basic underwriting rules in a rush to profit from extending as many mortgages as possible.
At this moment, I suspect the individual state attorneys general have the power, through civil suits and penalties combined with criminal prosecutions, to destroy the banking institutions that are guilty of this illegal behavior. This is, perhaps, the ultimate bargaining leverage, and it should only be given up in return for a settlement that will clearly heal the housing market.
Here are the several reasons why the proposed 46-state settlement is such a disastrous policy:
1. There is no overriding public interest in a settlement of the type proposed at this time. No one believes this settlement will fix the housing market. The state attorneys general are giving up leverage (which exists only through the banks' malfeasance) in return for what are minimal penalties to these giant financial institutions. As I previously pointed out, large monetary settlements have increasingly become a simple "cost of doing business" for financial institutions that break the rules.
To date, the Obama administration has attempted a seemingly endless number of programs designed to prevent foreclosures and heal the housing market. Each has been introduced with great fanfare and as an innovation that will not suffer from the failures of the previous program. Each has then failed.
I fervently hope that the latest program proposed by the administration will succeed. Unfortunately, I do not believe it will. My analysis, which is shared by professional housing economists, is that housing prices are headed substantially downward, by 20 percent or more, which will kick off a further weakening of the economy and a self-reinforcing system of foreclosures. This past Sunday, Joe Nocera's column in The New York Times profiled the analysis of Laurie Goodman, which says we should anticipate that a "staggering" 10 million of the existing 55 million mortgages will ultimately default. The country could not be more ill served by a policy that weakens our ability to ultimately end this cycle of destruction.
2. Since the start of the crisis, my research has indicated that only a radical restructuring of homeowner debt, combined with innovations in housing finance, will end the crisis. Prior to the bailout, Obama had the opportunity to bring banks to the table to negotiate this necessarily extraordinary change. The opportunity was missed. We bailed out the banks, but not homeowners.
Now a second opportunity exists. The state attorneys general have the ultimate leverage to demand a restructuring of the housing market without legislation. Right now we don't know what this should look like or what form it should take. But to give up this opportunity -- until the statute of limitations is exhausted -- would be inexcusable.
3. The banks (and even some government officials) assert that a settlement will spur a recovery of the housing market and the economy. This is absolute nonsense. In the words of MIT's Simon Johnson (emphasis added):
With roughly a quarter of all U.S. households with mortgages owing more on their loans than their homes are worth, it's no surprise that consumption, which accounts for 70 percent of gross domestic product, is restrained.
The consequent lack of demand discourages business investment, which means job creation remains weak. People are afraid of losing their homes and that fear keeps spending down and thus prevents them -- and their neighbors -- from getting jobs.
What can be done to break this vicious circle? One suggestion from some officials... -- and of course many banks -- is to accept a relatively small amount of money to settle the various robo-signing and other mortgage document cases that state attorneys general are pursuing. The claim is that this would put the banks back on their feet and spur lending. This is a complete illusion.
4. State attorneys general working in a coordinated action may sound positive. But in fact, it violates (at least in principle) the notion of federalism and state sovereignty that is a vital part of our constitutional government. The federal government is the place for coordinated national action.
Many of the programs that ultimately formed successful aspects of the New Deal were first developed by FDR as governor of New York. In effect, the states are laboratories for experiments, which can then be expanded in scope through the federal government. At a time when economic uncertainty is so high, we should not abandon the virtue of multiple experiments by individual states.
5. It is by no means clear that this settlement will have a meaningful impact on banks' behavior. This behavior has been so egregious that even The Wall Street Journal has been forced to acknowledge it. The idea of entitlement is anathema to a capitalist system. Yet the more we punish massive rule-breaking with the equivalent of a slap on the wrist, the more we create the impression -- among the general citizenry and the elite -- that we no longer have a fair capitalist society. As a consequence, the settlement has a strong chance of encouraging further misbehavior.
6. My study of the effects of extreme economic inequality, published as It Could Happen Here, demonstrated that as economic inequality grows, political polarization increases and legislatures become paralyzed. Sadly, we are seeing this today.
In contrast, the robo-mortgage scandal provides an opportunity for action by courageous individuals (state prosecutors and attorneys general) that does not depend on a consensus, which almost certainly prevent innovation. These individuals can make a difference in the lives of millions who suffer today -- even as our Congress fails to act. I hope they do not shrink from this awesome responsibility, one that they may not have sought but nonetheless possess.
The New York Times reports that "a handful of state attorneys general became so troubled by the direction this deal was taking that they dropped out of the talks. Officials from Delaware, New York, Massachusetts and Nevada feared that the settlement would preclude further investigations, and would wind up being a gift to the banks." These attorneys general are to be commended, and the other states should follow their example. Hopefully, their stance will not weaken over time.
There is no reason to violate the capitalist ethos, which is built on accountability and the rule of law, by agreeing to a multi-state settlement. This ethos and the accompanying rules of behavior are what made us a great nation. The far wiser policy is to develop an understanding of what actions will heal the housing market and work toward implementing a policy that realizes them.
Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.